Scrutinizing SEBI’s Propositions on Review of Buy-back Norms

As per the Companies Act, 2013 and the Securities and Exchange Board of India (SEBI) (Buy back of Securities Regulations, 2018), one of the main conditions for allowability of buy back of securities is that the ratio of the aggregate of secured and unsecured debts owed by the Company after buy back is not more than twice the paid up capital and free reserves, provided that if a higher ratio has been specified under the Companies Act, 2013, the same shall prevail. In 2016, the Central Government had specified a debt to capital and free reserves ratio of 6:1 for Companies within the meaning of clause (45) of Sec. 2 of Companies Act, 2013 which carry on Non-Banking Finance Institution and Housing Finance activities.

The above condition prescribed in the Companies Act and the SEBI regulations do not provide whether the financials to be examined for the computation of debt equity ratio are standalone or consolidated.

In January, 2019, infrastructure major Larsen & Toubro (L&T) had made an offer for buyback of shares for Rs. 9,000 Cr. However, SEBI rejected the buyback offer because the Company calculated the 2:1 debt equity ratio on standalone basis but not on consolidated basis. The ratio of the aggregate of secured and unsecured debts owed by the Company after buy-back (assuming full acceptance) was considered to be more than twice the paid-up capital and free reserves of the Company based on its consolidated financial statements. Later, in February 2019asked the SEBI to reconsider its buyback proposal.

In view of the above ambiguity, SEBI on May 22, 2019 issued a discussion paper to seek comments / views from the public on suggestions relating to review of conditions for buy-back of securities. The comments may be sent by email to buyback@sebi.gov.in or post by June 12, 2019.

The SEBI as per its discussion paper has released the following propositions:

• Financial statements would be considered on a conservative basis (i.e. both standalone and consolidated basis) for evaluating the various thresholds / conditions of buy back of securities.

• Post buy back debt to capital and free reserves ratio of 2:1 to be maintainedexcept where the Company buying back the shares has been notified under the Companies Act for higher debt equity ratio (i.e. Non-Banking Financial Companies (NBFCs) / Housing Finance Companies( HFCs) can buy back with a debt equity ratio of 6:1).

• Subsidiaries satisfying the following conditions to be excluded:
  • Such subsidiary is regulated;
  • Have issuances with AAA ratings;
  • Have debt to equity ratio of 5:1 on standalone basis.

For consideration of consolidated financial statements, the regulator has cited the following reasons inter alia:

• Consolidated financial statements show economic resources controlled by the group, its obligations and the results it achieves;
• Investors obtaining a complete overview of parent Company by examining the consolidated results;
• Results of unlisted subsidiary are also reflected in consolidated financials;
• In case of initial public offerings (IPO), profitability and other financial statements are also considered on a consolidated basis.

Few of the key aspects in the discussion paper to be looked into, are as under:

• Subsidiary to be regulated: The term “regulated” as used in the SEBI discussion paper for subsidiaries eligible for exclusion should be defined. The term seems to be too wide to include any kind of regulator such as sectoral regulators - Insurance Regulatory and Development Authority or Telecom Regulatory Authority of India, etc.

• Ratio of 5:1 not in line with Companies Act / RBI: The Companies Act prescribes a debt equity ratio of 6:1 for NBFC’s/ HFC’s. In addition, the RBI prescribes a leverage ratio of 7:1 for non-deposit-taking NBFCs (NBFCs-ND) with assets less than INR 500 crores. The ratio prescribed by the SEBI for subsidiary Companies should have been in line with these considering the quantum of debt is higher in view of the nature of business operations.

While the above discussion paper shall be applicable to a listed Company, it may have some bearing on compliance for an unlisted Company under the Companies Act especially on the following:

• Debt equity ratio requirement: The Companies Act, 2013 does not prescribe whether standalone financials or consolidated financials to be considered for buyback. Accordingly, in the absence of clarity in Companies Act, only standalone financials may be considered by unlisted holding Companies while buying back their shares even if the debt equity ratio of their subsidiaries is beyond 2:1.

• Other conditions for buy back permissibility: It appears from SEBI’s intent that consolidated financial statements would be considered for all other conditions prescribed for buy back permissibility. These conditions include the following:
  • Requirement of special resolution: One of the requirements of the Companies Act, 2013 and SEBI buy back regulations is that a special resolution must be passed if the buyback exceeds 10% of the paid up equity capital and free reserves.
  • Maximum buyback to be 25% of paid up capital and free reserves: Another condition of buy back regulations is that the buy back by a company cannot exceed 25% of the paid up capital and free reserves of a company.

The same is inconsistent with the Companies Act which does not state if standalone or consolidated financials to be considered and accordingly, typically only standalone may be considered.

The review of buy back conditions is likely to provide clarity to listed companies intending to buy back their securities. However, it is suggested that clarity is provided on the aspects discussed above and also amendments to be carved in the Companies Act to make the regulations at par with the SEBI paper.